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3 More Value Traps to Avoid Right Now

These stocks will sink you.

Back in April, we talked about how history's greatest investor, Warren Buffett, has two simple rules.

Rule No. 1: Never lose money.

Rule No. 2: Never forget rule No. 1.

Another big, sarcastic thank-you, Warren!Sounds great on paper, and that mind-set certainly helped Buffett on his path to billions. Practically speaking, though, the only way for us to be absolutely sure we won't lose money is to stuff it under our mattresses.

Assuming we're investing, however, we can avoid losing money by avoiding value traps. They're the stocks that look cheap -- and stay that way. Value traps are investing quicksand, and stepping in them is the surest way to leave your portfolio mired in the mud.

3 more value traps to avoid right nowI told you back then about five value traps to avoid -- the Quarter-Life Crisis, the Too-High Yielder, etc. But having spent a few more months digesting our recession, watching industries shake out, and debating with fellow Fools until they turn the lights on at our favorite local pub, I've defined three more value traps that we should all avoid.

1. The MiddlemanMiddlemen are frequently price-takers on both ends, meaning they've little clout with either their suppliers or their customers. The Middleman is just along for the ride, which is usually a bumpy one given their weak bargaining power. Picture low margins, high capital needs, over-capacity, and profits that swing wildly, usually at the whim of outside forces. Kind of like being the rope in a tug o' war.

I learned this lesson the hard way, recommending oil refiner Valero Energy(NYSE:VLO) to Fool readers in June of 2008. I predicted (correctly) that oil prices were due for a fall, but was wrong that lower gasoline prices would spur demand. Turns out that gasoline volumes fell in lockstep, dragging profits -- and Valero's shares -- down with them.

2. The IPOCompanies usually go public for one over-arching reason: Their investors want to cash in some chips, and they've found just the right time (and price) at which to do it. They think they've found a patsy -- you. Really, did you think the financial whizzes at Blackstone(NYSE:BX) took the company public in the summer of 2007 so that you could join in their successes?

But what about, say, a Google(NASDAQ:GOOG) or Microsoft(NASDAQ:MSFT)? Sure, they're both shining examples of IPO success, but they're also cherry-picked exceptions of greatness. Robust empirical research on five-year returns of IPOs from the years 1970 through 2000 found that they consistently underperformed the market after their first day of trading.

3. The Rule TakerThis might be the most poisonous value trap of them all. They don't have the power to make or break rules -- just take them. The Rule Taker is a company whose business is standing on the tracks as a technological freight train is about to pull through. Save for a Hail Mary or two, Rule Takers are out of options. Picture newspapers getting bowled over by the Internet, or the poor souls who bought into Blockbuster(NYSE:BBI) as Netflix(NASDAQ:NFLX) and the new age of digital content distribution took off.

Owning shares of these declining businesses is playing with investing fire. Sure, you might luck out with a turnaround or a dead-cat bounce, but failure is practically inevitable.

Shunning declining, rule-taking businesses no matter what their price.

The Anti-TrapNow consider one of our recent recommendations at the Fool's value-focused premium service, Inside Value:Monsanto(NYSE:MON). Monsanto is the 800-lb. gorilla of the world seed market, dominating competitors with its line-up of high-tech, high-yielding seeds that allow farmers to get a huge bang for their buck.

Unlike most freshly IPO'd businesses, Monsanto is a proven business that has produced market-thumping returns over the past several years. And with Monsanto CEO and Chairman Hugh Grant owning more than half a million shares of Monsanto, you can be darn sure he's working on shareholders' behalf.

Oh, and Rule-Taking? Consider this: Not only is Monsanto the global leader in seed sales, but most of Monsanto's competitors actually license its intellectual property for their seeds. Monsanto doesn't take the rules -- it makes them.

Two for the price of oneMonsanto isn't your run-of-the-mill value stock, but that's the way Philip Durell and I like it at Inside Value. Knowing that value comes in all shapes and sizes has been a secret to the product's success over the years, helping Inside Value to beat the market by more than 5 percentage points per recommendation since its inception in 2004. That and doing our best to steer clear of value traps, of course.

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Senior analystJoe Magyerhas no financial interest in any of the companies mentioned in this article. You can email himhere. Google is a Motley Fool Rule Breakers recommendation, while Monsanto and Microsoft are Inside Value recommendations. Netflix is a Stock Advisor recommendation. Motley Fool Options has recommended a diagonal call on Microsoft. The Motley Fool has adisclosure policy.